Raghuvanshi Mills Ltd. v. Commissioner Of Income-Tax, Bombay

V.S Desai, J.:— The question, which has been referred on this reference under section 66(2) of the Indian Income-Tax Act, 1922, is:

“Whether, on the facts and circumstances of the case, the provisions of section 23A of the Indian Income-Tax Act, 1922 (XI of 1922), are applicable to the petitioners?”

2. The assessee is a public limited company incorporated on the 28th of February, 1929. During the account year of the assessee-company, viz., April 1, 1942 to March 31, 1943, for which the relevant assessment year was 1943–44, the dividend declared by the company in its annual general meeting was less than what was required under section 23A of the Income-Tax Act, 1922. A question, therefore, arose whether the assessee-company was one to which the provisions of the said section were applicable. Now, the company's issued and subscribed capital consisted of 10,000 shares of Rs. 100 each. During the relevant accounting period, 4,695 of the shares were held by the 8 directors of the assessee-company together including amongst them Maganlal Prabhudas and his two sons, Ravindra Maganlal and Surendra Maganlal, their shareholdings being:

Maganlal Prabhudas 1,344 shares Ravindra Maganlal 1,168 shares Surendra Maganlal 1,100 shares

3. 4,754 shares were held by the relations of the directors including three other sons of Maganlal Prabhudas, viz., Bipinchandra Maganlal, Harischandra Maganlal and Krishnakumar Maganlal and his wife, Kantabai Maganlal. Each of the three sons held 1,000 shares and the wife held 771 shares. The remaining 551 shares were held by the members of the public. During the material time, Ravindra Maganlal & Co., which was a private limited company, was the managing agents of the assessee-company. The issued and subscribed capital of this private limited company was Rs. 5,000, which was equally subscribed by the five sons of Maganlal Prabhudas. The directors of the managing agency company were Ravindra Maganlal, Surendra Maganlal and Bipinchandra Maganlal, the first two of whom were also the directors of the assessee-company. Now, under section 23A, as it stood at the material time, companies in which the public are substantially interested were excluded from the operation of the section and a company was to be deemed to be one in which the public are substantially interested if shares carrying 25 per cent. or more of the voting power were held unconditionally and beneficially by the public and such shares were during the previous year the subject of dealing in any stock exchange or were in fact freely transferable by the holders to the other members of the public. According to the Income-Tax Officer the shares held by the assessee's directors or by the relations of the directors could not be regarded as the shares held by the public and since excluding these shares only 551 shares qualified to be shares held by the public, the public could not be said to be holding shares carrying voting power of at least 25 per cent. In his opinion, therefore, the assessee-company could not be treated as a company in which the public were substantially interested and consequently the provisions of section 23a were applicable to it. He accordingly made an order under the said section against the assessee-company. The decision of the Income-Tax Officer was confirmed in appeal by the Appellate Assistant Commissioner. The decision taken by the departmental authorities as to the applicability of the provisions of section 23a to the assessee-company was affirmed by the Income-Tax Appellate Tribunal. In upholding the decision of the departmental authorities, one of the members of the Tribunal took the view that the shares held by the directors of the assessee-company and the shares held by the persons interested in the managing agency could not be regarded as shares held by the public and since the total of those exceeded 75 per cent of the total number of shares, the assessee-company could not be said to be one in which the public are substantially interested. According to the other members of the Tribunal the shares held by the directors and the shares held by the relations of the directors could not qualify as shares held by the members of the public. When the matter came to this court on a reference under section 66(2), this court pointed out that it could not be said that in the case of every managing agency company the shareholders are controlled by the directors of the managed company and it was possible to have a managing agency company in which the shareholders may have no relationship with the directors of the managed company. The reason given by the Tribunal, therefore, that the shares held by the persons interested in the managing agency had to be excluded because such persons were under the control of the directors of the managed company was not correct and what was required to be found was whether they were in fact so controlled. Similarly, merely because the shareholder was a relation of the director was not sufficient to make the shares held by the shareholder as shares not held by the public. Mere relationship was not sufficient but what was further required to be found was that the shareholding of the relations was in fact controlled by the director. This court, therefore, thought it necessary to call for a further supplementary statement from the Tribunal in the light of its judgment. The Tribunal accordingly furnished a supplementary statement recording its finding that the shares held by the three sons of Maganlal Prabhudas, who were interested in the managing agency, were under the de facto control of their father, Maganlal Prabhudas, during the material time. On receipt of this supplementary statement from the Tribunal this court accepted the said finding. Now, it may be pointed out that in submitting its statement on the question framed by this court under section 66(2) the Tribunal had pointed out that controversy between the parties mainly related to the quality of shares held by the three sons of Maganlal Prabhudas, viz., Bipinchandra Maganlal, Harishchandra Maganlal and Krishnakumar Maganlal, who were interested in the managing agency along with the other two sons, who were also the directors of the assessee-company. It had, therefore, while submitting the statement of case, observed that the more appropriate question for reference was:

“Whether, on the facts and circumstances of the case, 1,000 shares each held by Bipinchandra Maganlal, Harishchandra Maganlal and Krishnakumar Maganlal in the capital of the assessee-company are held by members of the public within the meaning of the Explanation to the third proviso to section 23A?”

4. This court after having accepted the Tribunal's finding with regard to the shares held by the said three sons of Maganlal Prabhudas also agreed to reframe the question as suggested by the Tribunal and answered it in the reframed form in the negative. The assessee went in appeal to the Supreme Court against the decision of this court. The decision of the Supreme Court is Raghuvanshi Mills Ltd. v. Commissioner of Income-Tax [1961] 41 I.T.R 613, [1961] 2 S.C.R 978.. The Supreme Court held that this court had erred in proceeding on the footing that the shares held by the directors could never qualify to be shares held by members of the public. Similarly, the mere relationship was not sufficient and of no consequence unless control of the voting power held by the relative was proved. It pointed out that in order to find out the shares held by the public, it was necessary to find out whether there was an individual or a group which controlled the voting power as a block. If there was such a block, the shares held by it could not be said to be unconditionally and beneficially held by the members of the public. In the category of shares held by the public, only those shares could be counted which were unconditionally and beneficially held by the public, or, in other words, which were uncontrolled by the group which controlled the affairs of the company. The group itself might be composed of directors or their relations or nominees in different companies, but none could be said to belong to that group be he a director or a relative, unless he did not hold the shares unconditionally and beneficially for himself. According to the Supreme Court, therefore, since the view taken by the High Court that the shares held by the directors could not be said to be shares held by the members of the public was erroneous on the mere finding that Maganlal Prabhudas controlled the shareholding of his three sons, Bipinchandra Maganlal, Harischandra Maganlal and Krishnakumar Maganlal, the applicability of section 23A to the assessee-company could not be sustained since the total shareholding of Maganlal Prabhudas and his three sons would together come to 4,344 shares only. In order to decide whether section 23A could properly be applied to the assessee-company or not, what was required to be determined was whether more than 75 percent. of the shares were beneficially held by the public. The Supreme Court accordingly allowed the appeal, set aside the judgment and order of this court and remanded the matter back to this court to decide the question as had been originally framed, viz., “whether, on the facts and the circumstances of the case, the provisions of section 23A of the Indian Income-Tax Act (XI of 1922) are applicable to the petitioners?”

5. When the reference came back on remand, this court called for a further supplementary statement from the Income-Tax Appellate Tribunal on the question whether more than 75 per cent. shares of the applicant were not beneficially held by the public in the light of the judgment of the Supreme Court. The Tribunal after calling for reports from the departmental authorities submitted the further supplementary statement of the case required from it recording its conclusion that only 7,383 shares could be regarded as held by a group consisting of Maganlal Prabhudas, his five sons and his wife, and the rest of the shares could be treated as held by the public. According to this finding of the Tribunal more than 25 per cent of the shares could be said to be held by the public within the meaning of the Explanation. On receipt of this supplementary statement this court heard the reference again on 2nd April, 1964, and accepted the finding of the Tribunal. It was, however, argued before this court that, although shares carrying more than 25 per cent of the voting power were held by the public, the assessee-company could not still be regarded as a company in which the public were substantially interested because the other condition, viz., that its shares must be the subject of dealings on the stock exchange or must have been in fact freely transferable by the holders thereof to the other members of the public, was not satisfied. Admittedly, the shares of the assessee-company were not listed on the stock exchange at the material time. The assessee-company had always asserted that its shares were freely transferable. It was, however, contended on behalf of the department that in view of article 55 of the articles of association of the assessee-company, the directors had an absolute and uncontrolled discretion without assigning any reason to decline to register any transfer of shares and that amounted to a restriction on the transfer of shares and they could not, therefore, be said to be freely transferable. There was considerable controversy before this court on the question as to whether the said contention was permissible to be raised by the department as arising on the order of the Tribunal. This court took the view that the department would be entitled to raise the said contention. It, however, found that, although the contention arose on the order of the Tribunal, the Tribunal had not applied its mind to it. This court, therefore, called upon the Tribunal to furnish a further supplementary statement recording its conclusion in respect of this contention. The Tribunal accordingly has submitted a further supplementary statement recording its conclusion in favour of the assessee that its shares are in fact freely transferable by the holders thereof to the other members of the public. The assessee in the meanwhile had gone to the Supreme Court in an appeal against the order of this court calling for this further supplementary statement. It has, however, withdrawn the said appeal reserving to itself the liberty to raise the question as to whether the point on which the supplementary statement was called for arose on the Tribunal's order.

6. Along with the supplementary statement the Tribunal has furnished a list of transfers effected from 1929 to 1963, i.e, from the incorporation of the assessee-company up to date, and a perusal of this list will show that there have been transfers of the shares by some members of the public to other members of the public, transfers from the directors to the members of the public and from the members of the public to directors as also some transfers between the directors themselves. In the affidavit, which was submitted by the chairman of the board of directors before the Appellate Assistant Commissioner on the 7th of March, 1963, it was averred that, ever since the inception of the assessee-company the board of directors had never refused to accept any transfer whatsoever except in one solitary case in 1962, when the board was reluctantly compelled in the larger interest of the company as a whole, to decline the transfer of five shares in the name of one F.S Wadia, by the brother of the chairman of the assessee-company. It would thus be clear that the shares of the assessee-company have in fact been transferred without any difficulty or any objection being raised by the directors all along. It is, however, contended on behalf of the department that the fact that the shares have in fact been transferred is not sufficient to come to the conclusion that they are freely transferable. What is required to be found is whether there is or there is not a total absence of any restriction in the articles of association of the company with regard to the transferability of the shares. article 55 of the articles of association of the company, it is urged, is in the nature of a restriction on the transferability of the shares. The absolute discretion which is allowed to the directors to decline to register any transfer amounts to a restriction on the free transferability of the shares. It is argued that the transfer of shares is not complete until the transferee's name is entered as a shareholder in the registers of the company. Consequently, a refusal by the directors to register the name of the transferee would come in the way of the completion of the transfer and thus would amount to a fetter on the transfer. In support of this submission reliance is placed on a decision of the Calcutta High Court in Commissioner of Income-Tax v. Tona Jute Co. Ltd., where it has been held that a public company whose directors have absolute discretion to refuse to register the transfer of any share to any person whom it shall in their opinion be undesirable in the interest of the company to admit to membership, and are not obliged to give any reason for refusal to register, is not a company the shares of which are freely transferable to other members of the public within the meaning of section 23A of the Income-Tax Act.

7. Now, it may be pointed out that the articles of association of the assessee-company do not contain any restriction on the transfer of shares by one shareholder to another such as to be found, as for instance, in the articles of association of a private company. Article 55, to which reference has been made, is not by itself a restriction on the transfer of shares by a shareholder to another shareholder. It only gives the power to the directors to refuse to acknowledge the transfer or to register the transfer. A free transferability of the shares is a normal feature of the public limited companies and the articles like 55 in the articles of association in the assessee-company is to be found in the articles of association of nearly all public limited companies. As a matter of fact it is one of the standard articles of association prescribed under the Companies Act itself. The intention in providing such an article in the articles of association of a company, having regard to the normal feature of the company that its shares are freely transferable, is not to affect the general transferability of the shares. Its purpose is to arm the directors of the company with power to be exercised in special and exceptional cases where the transfer of shares in certain isolated instances is found to be undesirable in the interest of the company. The existence of such power in the directors of the company, therefore, could not be taken to affect the general transferability of the shares and treat the company's shares as not freely transferable. If it happens that the said power is used by the directors of a company in a manner as to affect the general transferability of the shares by the power being invoked in an unduly large number of cases so that transfer of the shares of the company is not permitted except in a few and isolated cases, the company's shares, though freely transferable under its articles of association may not, in fact, be freely transferable. What is required to satisfy the condition under the Explanation to section 23A is that the shares must, in fact, be freely transferable. In our opinion, the correct meaning of the expression “freely transferable” is that the shares in the first place be freely transferable, in the sense that there must not be any restriction contained in the articles of association restricting the general transferability of the shares by a shareholder to another person. Secondly, this quality of the transferability of the shares must not only be in name but the shares must be transferable in truth also. In other words, the company in its course of conduct must have freely allowed the transfer of shares without resorting to its power under article 55 except in few and exceptional circumstances and for extraordinary reasons.

8. In the present case there are no restrictions in the articles of association interfering with the free transfer of shares by the shareholders to others. The power under article 55 has also not been used by the directors of the assessee-company in such a manner as to create a fetter on the free transferability of the shares and to render them as not freely transferable. On the facts and circumstances of the present case, therefore, there is no difficulty in holding that the shares of the assessee-company are, in fact, freely transferable by the holders thereof to the other members of the public. The view that we are taking finds support from a decision of the Madras High Court in East India Corporation Ltd. v. Commissioner of Income-Tax which has disagreed with the Calcutta decision in Commissioner of Income-Tax v. Tona Jute Co. Ltd. [1963] 48 I.T.R 902. relied upon by the department, though not on precisely the same reasoning as we have adopted.

9. As we have already pointed out earlier, this court has earlier held on the earlier occasion that the shares carrying more than 25 per cent of the voting power are held by the public and in view of our finding now that its shares are also, in fact, freely transferable by the holders thereof to the other members of the public, it must be held that the assessee-company is a company in which the public are substantially interested and is consequently outside the operation of section 23A(1) by reason of the third proviso thereto.

10. Our answer, therefore, to the question as originally submitted by the Income-Tax Appellate Tribunal in its first reference, which, according to the Supreme Court judgment, was required to be decided by this court, is in the negative. The Commissioner will pay the costs of the assessee of the reference throughout in the High Court. Mr. Kolah for the assessee has also urged that the assessee is entitled to the costs of the appeal in the Supreme Court3 preferred by the assessee against the decision of this court calling for the supplementary statement of the case when it heard the reference on the last occasion on 2nd April, 1964.4 He has invited our attention to the order passed by the Supreme Court which says. “Costs costs in the High Court”.

11. Now, that order was made by the Supreme Court on the assessee's request to allow it to withdraw the appeal before the Supreme Court with liberty reserved to argue before this court at the hearing of the reference and in any appeal that might be filed before the Supreme Court against the order of the High Court that the question about the application to the appellant-company of the last part of the Explanation to section 23A of the Income-Tax Act, 1922—as it stood before it was amended by the Finance Act 1 of 1955—was never raised before the Tribunal and did not arise out of the order of the Tribunal. The Supreme Court allowed the assessee liberty to argue the said question and in that context made the orders. “Costs costs in the High Court”. Since in the appeal, which was withdrawn by the assessee, the assessee would not have been entitled to costs at all, the order “Costs costs in the High Court” has reference only to the liberty allowed to the assessee to re-argue the question before the High Court. Since that question has not been argued by the assessee before this court, as indeed it could not be argued in view of the earlier decision of this court, we do not think that the assessee will be entitled to the costs of the Supreme Court in pursuance of the order of the Supreme Court.